For Defense Stocks, Crisis Is a Cushion

 | Apr 03, 2013 | 5:04 PM EDT
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The U.S. equity indices were all down today, the Dow Jones Industrial Average off by about 0.76%, the S&P 500 was down about 1.05%, and Nasdaq was off by about 1.11%. The 10-year Treasury yield is also off by about 5 basis points to 1.81%. Gold is down $24 from Tuesday's close and $47.20 from Monday's close.  

The low ADP report on job creation in March, coupled with the Institute of Supply Management's non-manufacturing index declining to 54.4 from 56, has resulted in a negative response for almost all of the market's sectors.

Government contractors, however, couldn't care less. Every major government contractor is in the green as I write, and most are up big.

General Dynamics (GD) is up almost 2%. Northrup Grumman (NOC), Boeing (BA) and Raytheon (RTN) are up more than 1%. Lockheed Martin (LMT), the largest U.S. government contractor, is up about 0.5% and SAIC (SAI) is up a few cents over yesterday's close.

The increasing rhetoric and actions coming from North Korea, amid with the continuing private sector economic malaise in the U.S., is causing the immediate concerns about the federal budget and spending to take a back seat to anticipations of a the next great military adventure that will need to be funded.

The budget deficit in the U.S. has been declining for the past year because federal spending on the military has been decreasing, because of the winding down of military operations in Iraq and Afghanistan.

This has actually caused federal expenditures to contract, as I last discussed about six months ago, in the column "There Is No Recession."

The last time federal spending actually shrank on a year-over-year basis was after the Korean Armistice Agreement of 1953. The reduction in federal outlays then helped to facilitate the recession of 1953-54.

Kim Jong-Un has declared that North Korea is in a "state of war" with South Korea and has vowed to restart a plutonium reactor and uranium-enrichment plant capable of producing fuel for nuclear weapons. Now the U.S. will have to reverse its recent negative trajectory in military spending and increase it, probably quite substantially, regardless of sequestration or other federal budget issues.

I do not expect any of these companies to experience large increases in their stock prices as a result of the renewed military spending required by the North Korean situation. But that spending will remove some of the risk to revenue and earnings that these companies would have experienced had the federal budget issues and the winding down of operations in Iraq and Afghanistan remained these companies' primary concerns.

Harvard University recently released a report concluding that the financial costs to the U.S. of the wars in Iraq and Afghanistan are the most expensive in history, at $4 trillion to $6 trillion in total.  

So far, the Chinese and Russians have not indicated that they believe hostilities are imminent or even that they would back North Korea should a military conflict commence.

Regardless of the immediate outcome of this situation, the need to increase supplemental federal spending on the military will result, and the government contractors will benefit regardless of what happens with the federal budget. 

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